Consider the Solow model for an economy with a population growth rate of 4%, a depreciation...

Consider the Solow model for an economy with a population growth rate of 4%, a depreciation rate of 12%, a savings rate of 20%, and a production function of Y=5K^1/2N^1/2

What would the golden-rule savings rate be? Explain what the golden-rule savings rate achieves.

Explain what policymakers can do in order to achieve the golden-rule savings rate.

Solutions

Expert Solution

Rule: If initial savings rate is less than 0.5 (golden rule savings rate), then policies must be implemented to increase the savings as consumption increases. If initial savings rate is greater than 0.5 (golden rule savings rate), then govt must decrease the savings .

Policies govt can follow to increase/decrease savings rate:

1. Taxation: Increasing consumption tax will lead to increase in savings while reducing it will decrease savings

2. Income tax cut leads to increase in savings.

3.The government can also save more by reducing the budget deficit. One way of doing this is to curtail government purchases. Alternatively, raising taxes to reduce deficit or increase the surplus will also increase national saving by forcing people to consume less.

Rahul Sunny answered 1 year ago

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